Federal Reserve chair Jerome Powell recently hinted that a rate cut is on the horizon, marking the first time rates have been trimmed in over four years. This potential shift in policy has left investors wondering about the best course of action to take. Financial advisors suggest that those with diversified portfolios may not need to make significant changes in response to the rate cut.
Long-term investors who have most of their assets in target-date funds may not need to take any action at all. These funds are managed by professionals who handle necessary adjustments behind the scenes. On the other hand, investors who prefer to be more hands-on can consider making adjustments to their cash, fixed-income holdings, and the types of stocks in their portfolios.
Powell’s announcement of the need to adjust interest-rate policy comes at a time when inflation has decreased significantly from its peak during the pandemic. Lowering rates can help alleviate pressure on the U.S. economy. Businesses may feel more encouraged to expand with reduced borrowing costs as a result of lower interest rates. However, the uncertainty surrounding the magnitude and pace of future rate cuts means that investors should avoid making hasty changes to their portfolios.
Managing Lower Returns on Investments
With lower interest rates, investors can anticipate decreased returns on their low-risk holdings such as cash, money market funds, certificates of deposit, and short-term bonds. While high interest rates have led to substantial returns on these investments, the decline in rates is expected to lower these returns. Financial advisors recommend locking in high guaranteed rates on cash now and considering higher-paying fixed-income investments for excess cash that will not be needed for immediate spending.
Investors are advised to be mindful of the interest rate risk associated with staying in cash investments. While short-duration bonds carry less risk but offer lower returns, investors may need to consider raising their duration to maintain yields that have been consistent over the past few years. Bonds with durations of five to ten years may be suitable for many investors at present. Although advisors do not typically recommend adjusting stock-bond allocations, investors can consider reallocating future contributions to sectors that perform well when interest rates fall, such as utility and home-improvement companies, real estate investment trusts, preferred stocks, and small-cap stocks.
Navigating interest rate cuts requires a thoughtful and strategic approach. By understanding the implications of these policy changes and seeking guidance from financial advisors, investors can make informed decisions to optimize their portfolios in response to shifting interest rates.
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